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One Bankruptcy Court’s Analysis of a Motion to Dismiss Avoidance Claims: The Analytical Framework

A federal judge recently allowed a trustee’s preferential transfer claim against a law firm to proceed but dismissed a constructive fraudulent transfer claim.  The decision highlights the pleading standards and analytical framework for motions to dismiss such claims.  Insys Liquidation Trust v. Urquhart (In re Insys Therapeutics Inc.), Case No. 19-11292, Adv. No. 21-50359, 21 Bankr. LEXIS 2965 (JTD) (Bankr. D. Del. Oct. 28, 2021).

The debtors had paid the law firm $90,000 in the 90 days before the chapter 11 filing.  The liquidation trustee sued the firm to void the transfers and recover the fees.  The firm moved to dismiss, alleging the complaint failed to state a claim upon which relief could be granted under Federal Rules of Bankruptcy Procedure 7008 and 7012.

On a motion to dismiss, a “complaint must contain sufficient factual matter, accepted as true ‘to state a claim to relief that is plausible on its face.’”  In re Insys Therapeutics Inc., 2021 Bankr. LEXIS 2965, at *4 (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)).  The court “must draw all reasonable inferences in favor of the plaintiff” and the defendant has the burden to demonstrate that a plaintiff’s claims “are not plausible.”  Id. (citation omitted).

The bankruptcy court first considered the firm’s arguments to dismiss the preferential transfer claim.  The five elements for this claim under Bankruptcy Code section 547(b) are:

  • a transfer was made to or for the benefit of a creditor;
  • for or on account of an antecedent debt owed by the debtor before such transfer was made;
  • when the debtor was insolvent;
  • within 90 days before the bankruptcy filing (or between 90 days and one year for insiders of the debtor); and
  • which allowed the creditor to receive more than it would in a chapter 7 liquidation.

Before bringing a preference claim, a debtor must also conduct “reasonable due diligence” on the circumstances of the case and on possible affirmative defenses. 11 U.S.C. § 547(b).

The law firm argued that the complaint failed to show that it had received an antecedent debt, that it was a creditor, or that it received more than it would have in a chapter 7 case.  The firm also said that, before the case was filed, there was no showing that the debtors had conducted “reasonable diligence.” 

Specifically, the firm asserted that the complaint contained too few facts to satisfy the section 547 elements.  But the court noted that — as often is seen in preference lawsuits — the key facts appeared in a schedule attached to the complaint.  The schedule identified the payor and payee, the payment amount, the payment date, the check number, along with the date of, number of, and amount of the law firm’s invoices.  The schedule also revealed that the debtor had made payments on those invoices.  According to the court, these details constituted sufficient facts to show the law firm had received payments on account of antecedent debts and was a creditor.

The court also concluded that the complaint satisfied the fifth element of section 547(b): the complaint alleged that had the firm not received the transfers, it would have had an unsecured claim in a hypothetical chapter 7 case, and thus would have received less than full payment on the invoices.  In addition, the court found that the trustee had conducted reasonable diligence before filing the suit.  Accordingly, the court rejected all of the law firm’s arguments and allowed the trustee to pursue the preferential transfer claim.

The court next considered the constructive fraudulent transfer claim.  To successfully assert such a claim, a plaintiff must demonstrate that the debtor (i) received less than a reasonably equivalent value for the transfers at issue and, (ii) was insolvent when the transfers were made, was left with unreasonably small capital, or was left unable to pay its debts as they matured.  11 U.S.C. § 548(a).

The court found that the complaint’s allegations “merely parrot the elements of the statute and do not contain any factual allegations” concerning the specific prongs of the section 548 test.  In re Insys Therapeutics Inc., 2021 Bankr. LEXIS 2965, at *11.  The trustee argued that it was enough for the complaint to allege a lack of reasonably equivalent value because the question was one to be resolved through discovery, not on a motion to dismiss.  While the court agreed that the question “cannot be resolved at the motion to dismiss stage,” the trustee “must still allege some facts that would ultimately support a finding regarding the lack of reasonably equivalent value.”  Id.  But, the court pointed out that the complaint recited no facts to support the allegation. 

Likewise, the trustee’s allegations of insolvency were deficient.  The court noted that the complaint did not “plausibly allege insolvency” when the transfers occurred.  Merely reciting the language of the statute “is not enough.”  Id. at *13.  Therefore, the court dismissed trustee’s claim for constructive fraudulent transfer.